What is a mortgage?
In simple terms a mortgage is a loan used to purchase a piece of property. With a regular loan there is no collateral, your ability to repay the loan is analyzed and you are either approved or denied based on that. A mortgage is a bit different in that your house serves as additional collateral for the lender. For most people this is the largest loan they will ever take out, so the lender needs to mitigate their risk by including the home as collateral.
What are the different mortgage types, and which is right for me?
There are a wide variety of loans to choose from, and before we discuss some of the more common options, a good first step is to ask yourself some initial questions:
- How long do I plan on living in this house?
- How will my life be different in 10 years?
- How much cash do I want to keep on hand for other investments?
- How much risk am I comfortable taking?
The most common loan type is a fixed rate mortgage. This means your interest rate will be locked in for the length of your loan. The length of the loan can vary based on what you and your lender agree to, but the most common term lengths are 15 and 30 years. The longer term length the less your monthly payment will be. It is also important to remember that in the first few years the majority of your payment will go towards paying down the interest on the loan. As you proceed more and more of your payment will be used to pay off the principal of your loan.
Another common option is the adjustable rate mortgage or ARM. These mortgages provide a fixed rate for a set period of time (usually 3, 5, 7, or 10 years) and then after that period the interest rate is reset to be more in line with the new current rates. Often time’s borrowers use this type of loan to get a lower rate initially and hope that they will be in a better place to pay more down the line. There are limits to how much your rate can increase, but borrowers interested in this loan type need to work closely with their lender to make sure they understand all the details about how their loan and monthly payments could change down the road.
Other less common loans include jumbo loans for those borrowing over $625,000, VA loans for those who have served in the military, and 203k loans which include renovation costs. Be sure to speak with your lender about the different programs available and find out what works best for you.